Brian Sylvester: Despite a pullback in growth for China, copper (NYSEARCA:JJC) demand is likely to remain strong in 2012, according to Dr. Michael Berry, publisher of Morning Notes, and his co-author, Chris Berry, founder of House Mountain Partners. Other developing nations, such as Indonesia, should pump up demand, but supply from such regions remains a tenuous prospect. In this exclusive interview with The Gold Report, the Berrys explain how “home-brewed” U.S. copper companies will be an important part of the equation.

The Gold Report: In a recent edition of Morning Notes, you referenced some “sprouting” problems in China. What are those problems and are they likely to affect China’s economy?

Michael Berry: We spent a couple of weeks in Shenzhen, China, and Hong Kong last month. On the surface, there do not appear to be any real problems in China. The infrastructure is fabulous—new roads, tunnels, bridges and stadiums. There are a lot of institutional investors in China with a tremendous thirst for knowledge. But old China hands—and I’ve been there many times since the 1960s—feel that there are serious problems beneath the surface, including inflation, slowing exports, bad loans and overbuilding.

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During our visit to China, investment bankers we met with indicated that there are vacancies and see-through buildings in many cities. This is always a precursor of problems to come. China has an export-led economy and the U.S. and Europe, two of its main customers, have slowed down considerably. We may see a recession in Europe this year, which would bode ill for China, which counts the Eurozone as one of its largest trading partners.

An important question is how quickly can China transform itself into an economy with healthy domestic demand? That’s going to take years. There are also concerns about whether China can continue to grow at a breakneck speed of 9% or 10% per year. Most of the forecasts show China’s gross domestic product (GDP) will slow considerably over the next six years; however, it will still maintain growth levels above the Western economies. But problems are lurking in China, no doubt. The best we can hope for is a soft landing in 2012.

TGR: Paul Krugman recently wrote in The New York Times that China is on the verge of a massive real estate bubble. The World Bank recently lowered its GDP forecast for China to 8.4% from 9.1% in 2012.

MB: Growth will certainly slow, but China is better positioned to handle problems with overbuilding and bad debt than the U.S. China has been running huge surpluses for years and has accumulated significant foreign exchange reserves by pegging its currency to the U.S. dollar at artificially low levels. Japan recently inked a deal with China to buy its bonds. The Chinese currency and economy are slowly coming out of their self-induced isolation.

We remain cautious, however. China has a cushion here, but as we said before, there are some lurking issues and Paul Krugman touches on one in his piece.

TGR: How could a slowdown affect copper demand?

MB: Copper is probably the single metal that reflects good times in the world and growth. It is called the metal with a Ph.D. in economics because it’s so necessary for and indicative of economic growth. Expect supernormal growth of 5–7% in a number of emerging economies, which will keep demand for copper strong going forward.

The real question is from where will additional supply of copper come? There are the beginnings of a supply crunch in copper, which is affecting a number of mines worldwide. We are witnessing a combined supply-demand issue, not just a demand issue. Resource nationalism, falling grades and adverse weather are just a few issues affecting copper today. This is troubling but ultimately a good omen for junior mining companies involved in copper exploration.

Chris Berry: China is responsible for about 40% of global copper consumption, and copper is a 16-million-ton-per-year market. If GDP growth in China slows even from 9% to 8%, copper consumption has to fall in line unless other countries can pick up the slack in demand. What countries hold the potential to do this? Looking at demographics, potential demand and infrastructure build-out, several emerging markets come to mind including Brazil and India as well as “second tier” emerging markets such as Indonesia, Turkey or Colombia. If these countries do indeed grow at above-trend growth rates, you must then ask where additional supply is going to originate from—and supply appears tight going forward.

A notable example of a supply disruption is Freeport-McMoRan Copper & Gold Inc.’s (NYSE:FCX) Grasberg mine in Indonesia, where company management recently declared force majeure on copper exports. You can add labor strife to the list of issues potentially curtailing copper supply. Labor issues at mines promise to remain front and center as high metals prices make mining a more financially attractive pursuit. Grasberg is one of the largest copper mines in the world and the employees there have agreed to a 40% increase in pay over two years, however, I don’t believe the strike is fully settled yet, highlighting how thorny labor issues can be. Issues at the Grasberg mine have some very serious implications for copper supply going forward. So to summarize, between supply and demand, I think copper supply is the more important of the two to focus on.

TGR: The junior resource sector had a difficult time in 2011. The Toronto Stock Exchange Venture Composite Index, which is mostly composed of junior resource companies, was at about 2,400 in April, but had fallen to 1,450 by the end of December. Do you think we’ll see a sector rebound in 2012?

MB: There are strong headwinds for a lot of these companies and 2011 was unkind to the junior mining space in general. Very few junior mining companies have escaped the wrath of the pullback in commodities and overall panic at issues that have developed around the world. Investors must now focus on which companies can sustain themselves until we’re over the hump. We’re not there yet. The question will be which stocks can stand the test of time, can sustain their exploration and development activities and raise sufficient capital to fund operations in a difficult environment, to put it mildly.

MB: Revett produced 3 million ounces (Moz) silver equivalent and earned about $16 million (M) in the third quarter. The company also recently announced a $20M revolving line of credit from Société Générale. It produces the best copper-silver concentrate in the country from its Troy mine in Montana. The mine has a perpetual seven-year life because it keeps finding more copper and silver resources as it mines. It’s building in production and the kind of liquidity and strength it will need to manage any economic downturn.

We visited the company in early September. The management team is very much together. It got a good ruling from the Ninth Circuit Court of Appeals on the environmental impact of Rock Creek on grizzly bears and endangered fish. Rock Creek is a second ore body fully drilled out, and environmentalists have tried to block its development. It has 229 Moz silver and a couple billion pounds of copper in virtually identical geology to the currently operating Troy mine. There’s a good chance the company will be able to mine Rock Creek within the next couple of years.

Revett should prosper and could be the target of a takeout. It’s a very positive situation. The stock trades around $5/share, but it was $0.07/share a few years ago. That speaks well for the management and investors in Revett Minerals.

TGR: The line of credit is at London Interbank Offered Rates (LIBOR) plus 3.5%. Do you think that’s a bit high?

MB: Possibly, but certainly Revett can handle it. It’s producing and selling all the silver and copper concentrate it has, so a revolver is a good deal for it. These are catalysts that you want to see from time to time.

TGR: If Rock Creek moves ahead as planned, when would it reach production?

MB: I don’t think the environmentalist group will appeal to the Supreme Court. Even so, I don’t think the Supreme Court would hear it. It’s probably three to four years away from production.

The Troy mine will certainly sustain the company in the meantime. Management presentations indicate that Troy has perhaps 10 to 15 years of production left.

TGR: Is $5/share a good entry point for that stock?

MB: This stock is fairly volatile. If Rock Creek comes on, yes, I think $5/share will be an incredibly good bargain for investors. I’ve been watching Chief Executive John Shanahan now for several years and he’s completed everything he said he wanted to do.

TGR: In a recent edition of Morning Notes, you discuss some of the recent ups and downs of Quaterra Resources, Inc. (AMEX:QMM). You called the company’s Yerington copper project in Nevada “a company maker” even though Quaterra also has the high-grade Herbert Glacier gold project in Alaska.

MB: Tom Patton, the chief executive of Quaterra, bought Yerington out of bankruptcy for $250,000 in stock. Historically there are about 5 billion pounds (Blb) of copper at the Yerington Bear deposits. This past May, he announced he was exercising Quaterra’s option on it. There is going to be a large copper district there. There are three companies now in the area. Nevada Copper Corp. (NCU:TSX) has a very large, high-grade skarn deposit. Entrée Gold Inc. (ETG:TSX; EGI:NYSE.A) has some properties to the east of Yerington, which include the Bear deposit, a large, partially drilled out porphyry, and the MacArthur, an oxide-chalcocite run-of-mine project with 1.4 Blb of mine-ready, leachable copper. Quaterra drilled out the MacArthur oxide quite nicely and found a fair amount of higher-grade copper averaging about 0.5%. It could be leached directly and brought into production within two to three years for about $250M. The key to the entire district is the MacArthur property that Quaterra owns, in my opinion.

Quaterra has been cut in half in this pullback. We hope management will move to monetize some of its assets, either its Nieves silver property in Mexico, which may have 100 Moz silver in all categories, or even its 35% stake in Herbert Glacier, a high-grade, gold-silver resource north of Juneau, Alaska, which was recently discovered through drilling.

I may be a loner in this regard, but the MacArthur oxide-chalcocite deposit and the fact that it has a huge water resource are the keys to the entire Yerington district. I think the district holds 50–60 Blb copper. When I visited Yerington in September, Quaterra had five drill rigs turning. You don’t have five rigs turning on a property if you don’t think you’re really proving up and increasing the resource significantly.

TGR: Nevada Copper was shopping its project before its share price went down considerably. Which one—Quaterra, Entree or Nevada Copper—is most likely to be taken out first?

MB: Nevada Copper is the furthest along. A company like Antofagasta Plc (ANTO:LSE) might want to take it out. However, whatever company comes into the district is going to want to consolidate it. Having Nevada Copper would be a coup, but it would not help consolidate the district. From a strategic view point, Quaterra’s Yerington pit, MacArthur pit and Bear deposit are really the keys to the district.

There are already some big players in the district. Rio Tinto (NYSE:RIO) owns 25% of Entrée Gold. Ivanhoe Mines Ltd. (NYSE:IVN) owns 12%. But Entrée is three years behind Quaterra and Nevada Copper.

TGR: Arizona has some vast reserves of copper as well. Do you see a renaissance in developing copper juniors in Arizona?

MB: I do. On our way to China, Chris and I visited Tucson, where there are several great porphyry discoveries. ASARCO LLC, Rio Tinto and BHP Billiton Ltd. (NYSE:BHP) are there. One junior miner in particular, Redhawk Resources (RDK:TSX; QF7:FSE; RHWKF:OTCQX), has been drilling and it’s onto something.

Arizona, Nevada and Idaho are great states for mining. Given the unemployment in some of these regions, there is a new lease on life for junior mining companies to work in these states.

TGR: Redhawk is trading at about $0.42/share. Do you like that as an entry point?

MB: The stock is cheap, there’s no doubt about that. Its property, Copper Creek, is quite spectacular. When we visited in December, it had three rigs turning. There are close to 400 breccia outcrops of fairly small tonnage, but very high-grade copper, gold, silver and molybdenum. Red Hawk is looking for deep, but high-grade, thick veins that characterize big discoveries like Butte in Montana. I like the management team. It raised $20M earlier this year and it’s probably going to have to go back to the market again or do a joint venture. There’s lots of interest and it has confidentiality agreements signed with the big boys. There are smelters literally all around it. It’s got great infrastructure. There’s a good chance for a world-class discovery there.

MB: Quadra is a great case study. It has done a great job. You want to see that event that monetizes the shareholders. The Polish firm KGHM Polska Miedz S.A. (KGH:WSE) offered $15/share for the company. There is a lot of interest in U.S. deposits now. There’s a new life on mining and exploration, and there’ll be more takeouts in the future.

TGR: Do you have anything to add to that, Chris?

CB: There has been a lot of talk lately about what makes a metal critical. Certainly, copper is a critical metal based on its ubiquitous use throughout all facets of the global economy. Mineral deposits where resource nationalism isn’t a top concern, or a concern at all, like Arizona, Idaho or Nevada, deserve a second look and a premium in share price based on their location. I think we are sure to see more cross-border mergers or take outs like the KGHM/Quadra example as copper’s importance to economic growth is only magnified by an emerging middle class of billions in the years to come.

TGR: You gentlemen are about to launch a new product, the Discovery Investment Scoreboard. Tell us about that.

MB: About 10 years ago, I defined a technique called Discovery Investing because I was interested in discovery. All great wealth creation starts with discovery. I defined 10 rules or factors and continued to refine them over the last decade. Dr. Terry Rickard, a brilliant mathematician and former senior fellow at Lockheed, finally convinced me to put my discovery investing discipline in a software format. We use a powerful mathematical technique that he developed. It allows users to rate stocks in English vocabularies and develop an ordinal ranking. The number of companies that the system ranks, the database, is getting quite large. The most interesting aspect of the database is its ability to build a crowd score. It takes each individual user’s analysis and builds it into a single score, which allows investors to check their analysis against the crowd.

CB: The toughest part about the nano cap space is in trying to evaluate these companies, because traditional metrics don’t work. There are no earnings or cash flows so there is a great deal of guesswork involved. The Discovery Investment Scoreboard (DiS) is designed to take the guesswork out of evaluating these companies. We can rank any one of the companies we mentioned today—it doesn’t even have to be a nano cap.

We might look at the management of a company and you might say it’s average. I might say it’s excellent. At the end of the day, who’s right? Nobody really knows. There are still a lot of open questions. We’re aiming to quantify those opinions. The real bonus for the end users is the crowd score. Investors can see how their opinions rank relative to the crowd. Since I’ve been using the system, it has raised many questions about what I’m seeing that the crowd is not or vice versa. We think it has potential to shine a lot of sunlight on accurate valuations for junior companies.

TGR: Have either of you adopted a New Year’s investment resolution?

MB: In 2012, we hope to make DiS available to everyone who wants to analyze these companies. It’s going to be by subscription but we’re actually looking now for people who want to help us build the database. We’re planning to kickoff the system on Jan. 22 at the Cambridge House International Resource Conference in Vancouver. We haven’t priced it yet, but it will be affordable for the individual user. We’re going to have versions for institutional users that will be more detailed and quite a bit more powerful.

TGR: Jeepers. You might just put some analysts out of business.

MB: Chris and I actually sat with two analysts and two investor relations representatives in China and they loved it. We travel to Denver next week to conduct a focus group on the usage of the DiS.

CB: Once we explained the rationale and the background to them, it became a little bit addictive, because companies start popping up in your head and you think, “Gee, I wonder what the crowd thinks about this company or that company?” The whole idea of finding out what I’m missing or what I know that the crowd doesn’t is key. I think that’s what has a lot of people excited right now.

TGR: Thanks to both of you.

Dr. Michael Berry served as a professor of investments at the Colgate Darden Graduate School of Business Administration at the University of Virginia from 1982-1990, during which time he published a book, Managing Investments: A Case Approach. He has managed small- and mid-cap value portfolios for Heartland Advisors and Kemper Scudder. His publication, Morning Notes, analyzes emerging geopolitical, technological and economic trends. He travels the world with his son, Chris, looking for discovery opportunities for his readers.

Chris Berry, with a lifelong interest in geopolitics and the financial issues that emerge from these relationships, founded House Mountain Partners in 2010. The firm focuses on the evolving geopolitical relationship between emerging and developed economies, the commodity space and junior mining and resource stocks positioned to benefit from this phenomenon. Widely quoted in the press and a frequent speaker at conferences throughout the world, Berry holds a Master of Business Administration in finance with an international focus from Fordham University and a Bachelor of Arts in international studies from The Virginia Military Institute.

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DISCLOSURE:
1) Brian Sylvester of The Gold Report conducted this interview. He personally and/or his family own shares of the following companies mentioned in this interview: None.
2) The following companies mentioned in the interview are sponsors of The Gold Report: Revett Minerals Inc., Redhawk Resources Inc. Streetwise Reports does not accept stock in exchange for services.
3) Dr. Michael Berry: I personally and/or my family own shares of the following companies mentioned in this interview: Quaterra Resources Inc., Revett Minerals Inc. I personally and/or my family am paid by the following companies mentioned in this interview: Redhawk Resources Inc. I was not paid by Streetwise for participating in this story.
4) Chris Berry: I personally and/or my family own shares of the following companies mentioned in this interview: Quaterra Resources Inc., Revett Minerals Inc. I personally and/or my family am paid by the following companies mentioned in this interview: Redhawk Resources. I was not paid by Streetwise for participating in this story.